The Slow Torture of a Quiet Market

By

Michael Kahn

Updated March 5, 2003 5:17 pm ET / Original Sept. 15, 2019 5:52 am ET

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WHAT'S WORSE: a raging bear market where prices fall day after day and nothing seems to be right with the world, or a quiet market where prices slip a bit, recover and then slip a bit more, all on low volume?

It's like the proverbial frog in a pot of water on the stove. If the frog jumps into hot water, it jumps right out. If it jumps into the pot before it gets hot, it will sit there and boil to death without knowing what happened.

This market looks to be slowly coming to a boil, and anyone who is doing any buying or selling of any kind is getting cooked. Without clear signals of either breakdown or breakout, investors are left guessing, and that is never a good strategy.

Clearly, price action has been hard to gauge, and with supporting data going in different directions, things look even muddier.

For starters, during the early February decline, volume was below average. On the surface, that is a good thing because it tells us that there was no real urgency to sell stocks. Lower prices did not bring out more sellers as it would if we were looking at a new bearish trend.

But there was no volume surge during the Valentine's Day rally, either, and volume edged up a bit during the choppy market that prevailed over the rest of the month.

So, the market fell on low volume. It rallied on low volume. It paused on higher volume. None of this makes sense if you are looking for a developing trend, and that means that there has to be some other explanation for what is going on.

It's not too much of a leap to say that there is no trend and that the market is not going to do much until we get a handle on the outcome of the situation in Iraq. Charts are now backing up all the media banter, but unlike talking heads on financial television, charts can also let us know when the time for action truly arrives.

The Standard & Poor's 500, which has been in decline since mid-January, this week apparently broke down from a correction pattern (see Chart 1). It is hard to call it a countertrend rally, but the concept of correction can take many forms. This includes the wedge-like shape shown on the chart, and with the market-wide downside reversal seen Monday, the overall direction appears to be down.

CHART 1

But that contradicts the idea of a trendless market!

This is where we have to keep our time frames straight, as that correction pattern breakdown was not entirely convincing.

Could the market still be in a trading range? That appears to be the best explanation now, and market frogs sitting in the pot would be wise to think about jumping out. We just don't know how things are going to be resolved, so making big bets doesn't appear to be justified by the evidence.

As for finding that evidence, the most often overlooked tool in the analyst's toolbox is market sentiment. How do the masses feel about the market? More importantly, how are they translating that feeling into action?

Wall Street &ldquo;logic&rdquo; (if you can call it that) says that the masses are usually wrong, so contrary thinking can work in our favor.

But it's a little less insulting than that to the average investor. What it really means is that when the majority of investors have put their money where their collective mouths are (by buying, for example), then they have little money left to buy more. No buying means no demand and simple economics tells us that prices are not going to go much higher.

Conversely, when everyone is bearish and has already acted on that bearishness by selling, then the supply of stock dries up. Barring an extra-market calamity, prices will stop going down.

The latter condition is what we are facing today, according to at least one reliable sentiment indicator.

The ratio of put options to call options tells us how investors are thinking, because the more bearish they get, the more puts (vs. calls) they buy. The smoothed ratio of puts to calls (21-day moving average) is now where it was when the market bottomed last October. The higher the reading, the more pessimism there is, and the more likely that a bottom is near.

This is not a trading signal, but it does set the stage for a bullish response in the market. At a minimum, it weakens the case that the market is about to fall apart.

So where does that leave us? Price action is weak but not decisive, volume statistics tell us not to believe anything other than a nervous market and sentiment is more pessimistic than it has been in months.

Which means that there is no case for the bulls or the bears at this time. Technical analysis builds that case block by block, and relying on any single block alone is just wishful thinking.

Getting Technical Mailbag: Send your technical analysis questions to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn writes the daily "Quick Takes Pro" technical newsletter (http://www.midnighttrader.com). He is the author of two books on technical analysis, most recently Technical Analysis: Plain and Simple, and was Chief Technical Analyst for BridgeNews. He also is Director of Marketing for the Market Technicians Association (www.mta.org).

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